Define central bank digital currency, or CBDC?

Central banks issue digital currency known as CBDCs. Their value is correlated with the official currency of the nation issuing them.

When was the last time you made a cash payment for something? Even while physical money is still commonly used worldwide, its use has significantly decreased recently in various nations, particularly during the COVID-19 epidemic due to cash shortages and hygienic concerns. People are increasingly using digital financial transactions as they move away from cash. Compared to their physical locations, banks and other financial institutions conduct a significantly higher volume of transactions online globally.

The financial services industry has been affected by a number of recent digital changes, such as the rise of cryptocurrencies and blockchain technology. Central banks have begun to take notice of the role that digital currencies play in this narrative.

Government-issued digital currencies that aren’t tied to any particular physical good are known as central bank digital currencies, or CBDCs. They are issued by central banks, which also establish monetary policy and issue currency in addition to providing financial services to a country’s commercial banking sector and government. The People’s Bank of China (PBOC), the Bank of Japan, the US Federal Reserve System, and the Deutsche Bundesbank in Germany are a few examples of central banks.

Stablecoins and CBDCs are comparable, but they are not the same. A particular kind of private, stabilized cryptocurrency called a stablecoin is linked to a commodity, financial instrument, or other currency with the intention of keeping its value mostly constant over time. CBDCs are issued and managed by the state, in contrast to cryptocurrencies, which are decentralized.

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What kinds of CBDCs are there, and where are they being used right now?

There isn’t just one kind of CBDC; several strategies are being tested in different nations. An account-based approach like DCash, which is being used in the Eastern Caribbean, is one kind of CBDC. Customers maintain direct deposit accounts with the central bank through DCash. China’s e-CNY, a CBDC pilot program, is at the other extreme of the spectrum. It depends on private sector banks to provide and manage digital currency accounts for its clients. China presented e-CNY in the Beijing Olympic Games in 2022. The money may be used by athletes and visitors to make purchases inside the Olympic Village.

The European Central Bank is also considering a different approach, in which authorized financial institutions run individual permissioned nodes on the blockchain network to facilitate the issuance of virtual euros. In the last model, which is well-liked by “cryptophiles” but hasn’t been thoroughly tested by central banks, fiat currency—government-issued money unbacked by a commodity—would be distributed as anonymous fungible tokens to preserve user privacy.

What possible advantages might CBDCs offer?

Proponents of digital finance think that a variety of problems with efficiency, security, and accessibility may be resolved with new digital tools, one of them being CBDCs:

lower expenses. Financial service providers might potentially reduce their yearly direct expenses by $400 billion by allocating funds toward digital banking instead of physical infrastructure. However, lower costs have to be weighed against the substantial new technological investments that CBDCs would necessitate.

faster pace. The electronic payment systems in many nations might operate more quickly and effectively thanks to CBDCs. (As we’ll see below, this argument is losing strength.)

More accessibility for individuals without bank accounts. The percentage of US adults without bank accounts is less than 5%, whereas the global unbanked population was 1.6 billion in 2016. Mobile-accessible CBDCs have the potential to improve financial inclusion. Additionally, mobile money offers digital financial service companies access to untapped areas. Adoption isn’t certain, though, as many underbanked individuals could prefer the complete anonymity that cash provides.

increased safety measures. By guaranteeing that a transaction is completed and irreversible—even in the absence of a formal bank account—the implementation of a regulated digital currency that is accessible through mobile devices may improve payment security and lower the likelihood of fraud. Users may be able to “sign” transactions digitally through the controlled use of private-key cryptography, which would provide better peace of mind for all parties involved and shorten the time it takes for a transaction to become complete.

What worries people about CBDCs?

Even while central banks are excitedly investigating CBDC’s potential, there are a few obstacles to take into account. As money goes digital, it also becomes taxed as it can be traced. This is expected to constitute a barrier to voluntary adoption, according to McKinsey experts. The current state of technological instability is another problem. Due to technical difficulties, the digital edition of Eastern Caribbean DCash was unavailable for two months in January 2022.

Concerns have also been raised about the weak business case for CBDCs. For starters, the infrastructure for digital currencies may need more work from central banks than the comparatively small benefits justify. Furthermore, it’s possible that CBDCs won’t provide the faster speeds expected because many industrialized nations now use legacy (non-blockchain) infrastructure to enable rapid payments. Some countries, like Singapore and Canada, have concluded that there isn’t a compelling argument for digital currency at this time.